Retiree COLA: Budget buster or safety net?

Cutting back on automatic cost of living adjustments is the cornerstone of pension reforms being considered by state lawmakers. Supporters of the change say the COLA now paid to state retirees -- 3 percent per year, compounded annually -- is unsustainable. Opponents contend the changes would result in retiree pensions gradually losing ground against inflation.

Opponents contend the changes would result in retiree pensions gradually losing ground against inflation.

Both sides have figures to prove their points.

“It’s the one benefit that costs the most,” said Rep. Elaine Nekritz, D-Northbrook, one of the lawmakers who helped negotiate proposed pension reforms this spring. “That one benefit does constitute a significant portion of the overall cost of the pension benefit.”

The Teachers Retirement System provided figures that illustrate the point. In the 2011 budget year, which ended June 30, 2011, TRS paid out $4.2 billion in pension benefits. Of that, more than $900 million was to cover the cost of COLA increases. That represented 21 percent of the pension benefits paid that year, TRS said.

Moreover, the amount is increasing. In the 2007 budget year, TRS paid out about $3.1 billion in pension benefits, of which $561 million was attributed to COLAs. That year, COLAs represented 18 percent of total payout.

Growing COLA

“We’ve got people living longer, and it’s compounded,” TRS spokesman Dave Urbanek said of the increases. “That (compounding) contributed greatly to it.”

TRS had 90,967 members receiving pensions in the 2011 fiscal year. That was up from 79,728 in 2007. TRS has 362,121 members. The agency has not taken a position on the proposed pension reforms.

It’s the compounding component that lawmakers believe the state can no longer afford, along with guaranteed 3 percent pension increases.

The alternative that would be offered to people in the pension programs is to accept a COLA that is a maximum of 3 percent or one-half the urban consumer price index, whichever is less. Moreover, that COLA would not compound. Instead, it would be based on a retiree’s original pension. (This is the same COLA already available to “Tier 2” public employees, those hired after Dec. 31, 2010.)

Workers who choose to keep their 3 percent compounded COLA would no longer have access to state health insurance at retirement and future raises would not count toward their pensions.

Those who chose the lower COLA will keep access to retiree health insurance and have their pay hikes count toward their pensions.

If someone retired with a $50,000 pension and the first year COLA was 1 percent, the pension payment would be $50,500 the following year. If it was 1 percent again the second year, the pension would be $51,000.

Page 2 of 3 - Under the current system, that original $50,000 pension would be worth $53,045 after two years.

“The compounded COLA is one of the biggest cost drivers in the pension systems,” said Kelly Kraft, budget spokeswoman for Gov. Pat Quinn.

The lower COLA could save TRS between $33 billion and $37 billion, Kraft said. The State Employees’ Retirement System could see savings of $23 billion to $31 billion and the State University Retirement System $10 billion to $20 billion.

Benefits would lag

But critics said the lower COLA would erode pension benefits as they fail to keep up with inflation. The American Federation of State, County and Municipal Employees analyzed the effects on a state worker pension if the changes had gone into effect 25 years ago.

The union started in 1987 with a pension beginning at $15,000, an amount the union said is very close to what a typical state retiree received at the time. It then computed changes to that pension based on the current, 3 percent compounded COLA and the proposed COLA.

After 25 years, that $15,000 pension would have grown to $30,492 annually under the current system. Under the proposed new formula, that retiree would be receiving only $20,235 a year.

Over the 25-year period, the retiree would have collected nearly $547,000 in pension payments under the current formula, but less than $448,000 using the new formula.

Moreover, the union’s calculations determined pensions wouldn’t have kept up with inflation under the new formula.

“It illustrates the real cost to retirees of the provision to gut the COLA protection against inflation,” said AFSCME spokesman Anders Lindall. “It shows how critically important a modest compounded COLA is to retaining the purchasing power of the pension benefit after retirement.”

However, state Sen. Bill Brady, R-Bloomington, another pension negotiator, said it isn’t necessary for a pensioner’s COLA to keep up with the consumer price index.

“In the CPI equation is a housing figure,” Brady said. “Upon retirement, most people have their house paid off. It could be CPI is an over-inflation.”

“Most folks who are retired are pretty settled with their housing situation,” Nekritz added. “We didn’t need to have a full CPI increase because we didn’t really have to take into effect increased housing costs.”

Brady said there is a trade-off in the proposed changes, but the changes are fair.

“It appears to us to be, relatively speaking, a very lucrative pension,” he said.

Kraft reiterated that the current system can’t go on.

“Should an employer be solely responsible to provide full retirement security?” Kraft said. “Our stance is we can’t afford the current system.

“What we can do is make some needed changes to stabilize the systems, which will provide benefits to the men and women who have faithfully contributed to the system,” Kraft said.

Page 3 of 3 - Doug Finke can be reached at 788-1527.

Correction: State Sen. Bill Brady is a pension negotiator who was quoted in this article. A previous version attributed his comments to the wrong member of the General Assembly.